Raphael Pitoun: “I very much doubt that at this stage of the cycle, it makes sense to invest in companies with a leveraged balance sheet”

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Raphael Pitoun: “Dudo mucho que en esta etapa del ciclo tenga sentido invertir en empresas con un balance apalancado”
Raphael Pitoun, courtesy photo. Raphael Pitoun: “I very much doubt that at this stage of the cycle, it makes sense to invest in companies with a leveraged balance sheet”

The Stryx Global Growth Fund, a global equity fund, only invests in the best companies in the world in terms of quality and growth. In fact, it is a growth strategy with a low number of expositions: between 17 and 25 shares. To this we must add that its rotation is of around 20%. Some of the companies stay for more than fifteen years. Raphael Pitoun, CIO of Seilern Investment Management, explains the reasons why the fund is concentrated: “The companies you are looking for are very rare,” he says.

The strategy, which Capital Strategies markets in Spain, selects stocks between industries and sectors that present high barriers to entry, strong pricing power and visible growth prospects. “The companies in our portfolio combine a sustainable competitive advantage with a strong balance and high profitability,” explains the CIO of this boutique manager with $ 400 million of assets under management in this interview with Fund Society.

How does your fund differ from other global equities funds?

The Stryx World Growth fund only invests in the best companies in the world in terms of quality and growth. Stocks are selected from industries and sectors with high barriers to entry, strong pricing power and visible growth prospects and the companies combine a sustainable competitive advantage with a strong balance sheet and high profitability. Stryx World Growth is a concentrated fund of between 17 to 25 stocks as the companies we are looking for are very rare. The fund has a low turnover of around 20%; some of the companies are in the portfolio for more than fifteen years.

What is your broad outlook for equities in 2017?

We continue to have a positive Outlook for Equities in 2017. The level of systemic risk is moderate as the banking sector restored its profitability and the amount of leverage in the private space is not disproportionate. There is still plenty of liquidity and except if the Federal Reserve makes errors and tighten too quickly this should continue to be the case. We are not very optimistic regarding the ability of the new US administration to boost growth but overall global growth prospects remain acceptable. Despite indexes reaching recent highs, the investment world is still largely skeptical and underweight in Equities. This bodes well for a continuation of the rally in the foreseeable future. We only start to perceive the first signs of market euphoria since a few weeks and these signs are still far from a bubble.

In which areas do you see more opportunities?

We are not keen to make any macroeconomic gamble and the companies we invest in are also chosen because they are more immune than an average company to any kind of macroeconomic trend. What we can say is that with the ongoing sector rotation, which favored low quality sectors, indebted companies and banks, our highly growing and predictable companies are very much affordable. Also, I very much doubt that at this stage of the cycle, it makes sense to invest in companies with a leveraged balance sheet for example.

Three themes for this year

One of the themes we have been working on recently is the consumer staples industry. It looks like the sector growth algorithm is getting increasingly challenged by competition, new consumption habits, the direct to consumer business and slowing developed markets. We become structurally more prudent about this sector and, for example, we sold our 17-year-old position in Reckitt Benckiser a few weeks ago.

The other theme, which looks interesting to us, is the healthcare sector. We progressively moved our exposure from pure drug manufacturers to medical devices makers. The latter often have a good pricing power, interesting strong growth prospects and high barriers to entry. We do not think they will be completely immune to the huge pressure on developed market’s healthcare system but, if chosen carefully, some of them make very interesting investments.

Last, we have been working on robotics. Most companies we invest in have a plan to increase their capital expenditures on automation. With inflation fears coming back and full employment in some markets, this should only accelerate this trend. What we see on that front is similar to what companies experienced in the 2000s when they outsourced production or open plants in low-cost countries: when one competitor start doing that, the others are obliged to follow creating a strong halo effect. This should benefit companies such as Fanuc in Japan.

Are we seeing a rotation from growth to value?

Yes, it is visible that some investors shift from growth investment into value. On our side, we are very wary of using the distinction between growth and value. We are quality growth investors and it is a big difference with what is considered a growth investor. We do not bet on growth prospects for one or two years but for the long term and growth is only one of the criteria we are looking at.  We do not have any style or do not follow any fashion: we use the equity market as a tool to invest but our investments are not in the equity market but in companies.

What are your capabilities of capital preservation?

Our capabilities of capital preservation are very high from both a company and portfolio perspective. At a company level, the risk of default is very low as the companies we aim at investing in are very established businesses (on average, they were founded in 1944), have healthy businesses and are highly cash generative. From a portfolio perspective, the main driver of the performance is the earnings generation rather than multiple expansion or fragile dividend payments. For investors who have a sufficient time horizon across the cycle, the capital should be not only preserved but increased significantly.

How do you identify areas of the market that may provide stock ideas?

Our ideas are purely proprietary and based on the work on our internal research team. We also capitalize on our own track record of 25 years and know how in the quality growth investment. Finding new ideas comes from two ways. Firstly, we are using a quantitative screening as we want the companies to tick many boxes in terms of track record, growth and balance sheet. Secondly, we identify structural growth themes and, often when we look at one company, it often leads to another one. But, again, identifying an idea is the very first step of a long process; we then deep dive and investigate on all the aspects of the company and this can take between six months and one year before a company is approved for investment.

We have seen a upward trend in US equities because of Trump, is this trend sustainable?

To put things into perspective, the change in the market environment has started last July before the US elections. The stimulus plan announced in China, and decreasing deflation fears in Europe already helped the equity market. The election of Trump made some investors think that the US could also see better growth prospects. That’s a point we are doubtful about given the local political context and the division inside the Republican party. But again Trump was only one explanation for the rally and a potential disappointment, even if it will not help, should not entirely break the positive market dynamics.

Why you do not invest in Banks? And in Oil? And in Insurances companies?

This is explained by our investment philosophy. We only invest in companies we can understand and analyze. Banks and insurance companies are not transparent enough. On top of that, there is no real structural growth driver and the capital intensity in the financial sector is going up. As far as oil is concerned, we want the earnings growth to be as predictable as possible. For oil companies, we are not in a position to forecast even the revenue line in an accurate manner.

 

Matthews Asia: “Yen Weakness is not a Requirement for Japanese Stocks to Perform Well This Year”

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Matthews Asia: “La debilidad del yen no es un requisito para que las bolsas japonesas lo hagan bien este año”
Photo: Kenichi Amaki, Matthews Japan Fund Portfolio Manager . Matthews Asia: “Yen Weakness is not a Requirement for Japanese Stocks to Perform Well This Year”

Regarding the factors that make him optimistic about Japanese equities in 2017, Kenichi Amaki, Lead Manager of the Matthews Japan Fund, notes that over the years, the Japanese economy has faced many macroeconomic headwinds, but this year many of them have turned into tailwinds.

As an example, the fund manager mentions that improved PMIs, the acceleration of wage growth, and the announcement that the Japanese government will expand fiscal spending for the first time in three years, all bode well for the strength of the economy.

And then, he says, we run into inflation. “Japan has been caught up in deflation for most of the past two decades and even I anticipated that after a few years of positive CPI growth, the economy would sink back into deflationary territory. However, given the weakness of the yen, a potentially inflationary environment in the United States and elsewhere, coupled with rising commodity prices, it is time to rethink this. I think that, in all likelihood, inflation may actually accelerate this year.”

The other note in this positive context is the yen, although Amaki likes to stress that its weakness is not a requirement for Japanese stock markets to perform well this year, although “it is helpful owing to its effect on corporate earnings.” Prior to the US election, the exchange rate ranged from 103-104, “however, I remain skeptical that it will weaken to as low as 125.”

He explains that this is how Matthews Asia arrives at the optimistic scenario it envisages for Japan this year: “All these factors, and especially our vision of inflation are good news for Japanese stocks and it is a tailwind that, frankly, we have not had before. It should be supportive of Japanese revenues, trickling down to earnings and eventually to share prices.”

For the Matthews Japan Fund manager, the two areas which are likely to benefit greatly are the retail sector and the financial sector. “Japanese retail companies underperformed last year, owing to expectations of a return to deflation and renewed price competition amongst retailers. However with a change in both currency and inflation expectations, those things might be viewed positively for the retail sector,” he anticipated.
Meanwhile, the fund manager points out that yield curves steepened globally, “including in Japan,” which should be positive for Japanese banks and life assurance companies.

In fact, 3 of the top 4 positions of the fund he manages are Japanese financial entities: Mitsubishi UFJ, Tokyo Marine Holdings and Sumimoto Mitsui.

Shinzō Abe Administration

But the question that everyone who is looking for opportunities on the Japanese stock exchange has in mind is: Is Abenomics working?
Shinzo Abe boasts one of the highest approval ratings amongst heads of state worldwide, which is basically another positive factor. Furthermore, the inflows into the stock markets are another reason to be optimistic.

“By the end of October last year, international investors had sold almost two-thirds of what they purchased at the start of ‘Abenomics’. Meanwhile, the Bank of Japan will be buying 6trn yen of Japanese equities annually, while corporate share buybacks have been robust, hitting 5trn yen in 2016, and are expected to continue apace this year,” he explains.

Meanwhile, Amaki adds that domestic pension funds are short of their target allocations for Japan, and goes on to explain that, he estimates that there is likely to be around 10-15trn yen of domestic buying into the asset class this year. “If international investors change their attitude to Japan and decide to up their weightings, it could really propel the market upwards.”

Trump and Car Manufacturers

But of course, as in the rest of the world, the risk for this optimistic scenario is called Trump. Especially for the Japanese automotive industry, which has many interests in the United States

Without going any further, Toyota imports from Mexico only 70,000 units of the 1 and a half million cars it sells in the United States, “it’s a tiny number, but it will still be affected to some extent. All Japanese car manufacturers will be affected,” he states.

Therefore, in terms of the fund’s exposure to the United States, Amaki has been reducing the positions of those companies that have US competitors producing in the United States. “Because, if US companies are actually producing in China, they will actually be in the same position as a Japanese company which also imports its parts from China.”

“His protectionist policies could have a big negative impact, while any U.S. policy mistakes causing U.S. economic reversal are also a concern.” In this regard, the risk comes from the mix of fiscal incentives envisaged by Trump and the rates hikes of the Federal Reserve, since this could hamper US growth.

“Policy mistakes causing deflationary trends would also be a threat to the global economy and remove all the inflationary tailwinds we discussed earlier.” Amaki adds.

“Such risk scenarios will inflict pain on all of US trade partners, not just Japan.” He concludes.

Insight: “We Reduce Market Volatility by Buying Very Short-Term Bonds”

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Insight: “Comprando bonos a muy corto plazo logramos reducir la volatilidad del mercado”
Emma Duhaney, Senior Product Specialist at Insight, a fund management company owned by BNY Mellon. / Courtesy photo. Insight: "We Reduce Market Volatility by Buying Very Short-Term Bonds"

How can portfolios be protected from volatility in a context so marked by politics and with so much uncertainty? This is perhaps one of the headaches for many managers, for which each firm has been developing different strategies that allow them to contain the risks. In this interview, Emma Duhaney, Senior Product Specialist at Insight, a management company owned by BNY Mellon, explains the formula which they apply in the management of BNY Mellon Global Short-Dated High Yield Bond.

“We focus our investment in bonds with a very short-term maturity, which allows maximum reduction of volatility. The key is the assets we choose and the way we build the portfolio to ensure that there is no default,” explains Duhaney. In her opinion, the key is to reduce volatility by buying the bond when it is about to materialize because, “default risk is minimal and it is unlikely that the price will move.”

This is the strategy applied to the BNY Mellon Global Short-Dated High Yield Bond Fund, an actively managed fixed income product that seeks to provide returns in excess of Libor. In order to do this, it invests mainly in a high-yield bond portfolio, in other words, lower than investment grade, in the short term, but also invests in convertibles, loans, and securitization bonds. In addition, it selectively sells protection in credit derivatives.

Now, for this principle to work, how the portfolio is made up, and which companies are part of it, are both very important. “We have a team of analysts who analyze companies. When your strategy is short bonds, there are a number of things that you have to check, including: whether they are companies that will be able to pay, their capital structure, when their bonds mature, whether the company is flexible, or if their benefits increase. In short, all the aspects that come into play to evaluate its ability to pay or its capacity to refinance,” says the expert.

She doesn’t like the retail sector because it is extremely changeable, but she does not discard any others because, she points out, they focus more on the duration and quality of the bond than on a specific area of economic activity. “We have a system called ‘the main check list’ by which we seek to identify any risk that can be generated in companies and which affect profitability. For example, if there are chances of it being bought, or any possible regulatory risks. We try to detect any aspect that could jeopardize the payment of their bonds,” she points out.

For Uncertain Environments

According to Duhaney, this strategy is perfect for times as uncertain as they are now, because it is designed for environments with increasing spreads and changing interest rates. “We find that many traditional high yield fund managers are selling short-term bonds because bonds with less than one year of maturity are not within their index, which allows us to buy the type of asset we want at cheaper prices. And since we work in the short-term, it is easy to have liquidity to continue acquiring new bonds,” says the expert.

Among the risks she identifies in the market right now, Duhaney agrees with the widespread views of the sector: politics. “It always raises uncertainty, and right now we have elections coming up in Holland, France, and Germany. This always means volatility because investors have seen big changes in the last UK and US elections, so they are worried about what will happen in Europe this year.”

To political risk, we must add the decisions taken by central banks such as the European Central Bank (ECB) and the Federal Reserve (Fed), since obviously a rise in interest rates will impact the bond market. “We believe that the Fed will raise rates twice this year, maybe if the growth of the US economy is very strong, it will be more; but, currently, we think it will be twice in 2017,” she says.

She is cautious regarding Trump, and is waiting to see what the first economic measures taken by the new administration will be, and reminds us that trade and tax policies are the most important ones because of the impact that his electoral promises would have on them. As a matter of fact, she focuses on the commercial side and warns that it would be highly negative if Trump “gets into a trade war because it would cause significant restrictions on world trade.”

Fixed Income Or Emerging Equities? It All Depends On Whether Reflation Triumphs

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¿Renta fija o renta variable emergente? Todo dependerá de si triunfa la reflación
Foto cedidaPhoto: TitoAlfredo, Flickr, Creative Commons.. Fixed Income Or Emerging Equities? It All Depends On Whether Reflation Triumphs

The future evolution of emerging markets is inexorably linked to three variables: trade policies applied by Donald Trump with respect to these countries, the strength of the dollar, and the pace of rate hikes by the US Federal Reserve. And experts still have doubts about their evolution, due to uncertainty about the US president’s future policies.

“The key variable for the returns and the evolution of emerging currencies is the dollar. The initial reaction to Trump has been one of strength but we do not know if this will continue, it will depend on politicians,” said Nicholas Field, Emerging Markets Equity Manager, at a Schroders event with reporters in London. “If rates rise in the US, that money could come from the emerging world,” warned Ugo Montrucchio, Multi-asset Manager at the fund management company, but he also indicated that another variable could enter the equation: if investors associate inflation – which is what forces such rate increases – to more growth, the effects on developing markets could be positive.

In this environment of uncertainty, one thing is clear: after three years being underweight in emerging markets in the management company’s multi-asset portfolio, the scenario is now beginning to be favorable for investment, and always with very selective and active management, which is the most sensible in a scenario in which dispersions are once again strong.

But, let’s not forget, with the uncertainty… also between the two, of whether it will be emerging equities, or fixed income that will do better. “For some weeks the markets have been immersed in the reflation story. For me, the dilemma in 2017 is whether there will be a very rapid reflation, in which consumption and growth will accelerate, or all expectations of inflation and growth will lead to a world in which restrictive monetary policies by the Fed Will dilute that growth by mid-2017. The bias is now toward emerging equities, where we see more potential than in fixed income, but as we enter into the new year, everything will depend on US policy, and on the reaction of central banks,” says Montrucchio.

Field points out the attractive valuations of emerging equities, where the question is how much each country has adjusted their account balances, and where he sees opportunities in markets like Brazil (the country where to increase exposure). Although negative in Mexico and South Africa, he believes that this last market could be the turnaround story of 2017, just as the Rio stock market has been this year. As regards China, the vision is not too pessimistic because, despite the heavy debt it faces, it has adequate mechanisms, says Field. He declines to comment regarding trade relations with Trump and the problems that could be derived from this aspect, as currently all you can do is speculate, he says.

And emerging- markets’ debt?

For Jim Barrineau, Co-Head of Emerging Markets Debt Relative Return at Schroders, if the reflation story wins, it will probably benefit stocks to the detriment of emerging debt, but “if we see rate hikes that go too far and too fast, there could be significant opportunities in fixed income,” he explains.

The expert, who reminds us of the strong returns seen in 2016 in some emerging debt segments, argues that if global debt markets remain stable, the search for profitability in emerging markets will continue. And points out positive points for the asset, such as currency valuations (which despite having regained ground in 2016 after the falls of recent years, are still below their peaks) or the recovery of commodity prices, which can benefit many countries in Latin America (except Mexico), not to mention that the markets have already priced-in a US rate hike in December and two next year.

Among the markets with more opportunities, and which can play the reflation story, is Brazil, less affected by the Trump policies, as well as some in Asia. In general, his proposal focuses on debt with low duration, and outside the investment grade segment, that is, in high-yield, where he sees much appeal. And always, with active management: “When investing in emerging debt, passive management does not make sense,” he says.

WE Family Offices: How To Manage HNW In An Increasingly Globalized Environment

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WE Family Offices: Cómo gestionar grandes patrimonios en un entorno cada vez más globalizado
Santiago Ulloa, founding partner of WE Family Offices. Courtesy Photo . WE Family Offices: How To Manage HNW In An Increasingly Globalized Environment

There is no doubt that globalization has changed the world stage at all levels, and the wealth management sector has not been able to escape the effects of this economic, global, and cultural process. That is why, as announced last September, the US company, WE Family Offices, decided to sign an alliance with MdF Family Partners – with whom they already had a collaboration agreement which had been in place for over a year and a half – and with Wren Investment Office, a company with London Headquarters which advises UHNW families in the UK and Europe. Thanks to this strategic alliance, WE Family Offices can respond to the needs of its increasingly global clients.

Presence outside the United States

Santiago Ulloa, a founding partner of the American firm, which already has 50 employees, provides advisory services for assets worth over 6.8 billion dollars as of September 30th, 2016, and offers service to 70 families, says that “the reason for which we saw a need to have a presence outside the United States was because we observed that many of the families are already global, are in several jurisdictions, and have children spread across different continents. For one reason or another they want access to advisory services also from Europe, since in some cases they have more presence there. We have also been fortunate to find a team that has the same mentality and vision as us.”

The three firms share the same view on how to manage high-level family wealth in the long run. Qualities such as transparency, objectivity, or not having their own product, are all part of the philosophy with which they serve clients. Ulloa says that in this alliance, the firms involved will “function as independent companies, each with their own relevant licenses in their respective countries, but we will share investment opportunities search teams and asset advisory teams for issues at fiscal and succession planning level, or of global planning”.

In this regard, the common investment committee will be one of the most interesting contributions of this alliance. The main idea is to share the investment strategy, “for example, if we think that we have to reduce the risk of the portfolios in the stock market, we want it to be a strategy developed and agreed on by the investment committee. However, the implementation will be local, through the local investment vehicles that have the appropriate taxation for each client. We will also try to look for investment managers that will serve all firms,” adds Santiago.

Search for joint opportunities

There are many competitive advantages that come from having a global presence, among them “the possibility of finding investment opportunities together, which we can all share and thus obtain a greater critical mass that allows us to invest for our clients under the best possible economic conditions”.
These synergies are especially important at a time when WE Family Offices believes that “the most interesting investment opportunities are currently found in private markets.”

Santiago Ulloa points out that “we currently have a total of more than 800 million dollars committed in illiquid operations, and disbursed more than 600 million dollars.” However, the company considers that such investments are not suitable for all families “we have to carry out strategic planning in advance to fully understand the family’s entire wealth, their liquidity needs, cash flows, etc.,” says Ulloa.

Illiquid investments

Illiquid investment opportunities are sought in different sectors around the world; real estate, energy, and technology are the company’s big commitments.
In real estate they are investing in the United Kingdom, Germany, Switzerland, and the United States. Two of the most important recent operations were “the one in which we participated together with the Collier family’s family office, and another in which we co-invested with Starwood Capital in a project of more than 20,000 rental homes in the United States,” says Santiago. In the energy sector they invested in a company specialized in solar power which was later bought by a JP Morgan fund, and the one in which they have many hopes for investment and for the future is the technology sector, especially in the field of artificial intelligence in which they are working together with a specialist based in Silicon Valley, to where they plan to organize a trip with some of their clients, offering them the opportunity to get to know this sector first hand.

The average worth of the families that decide to commit to the firm is increasingly higher, reaching an average of 100 million dollars. In some cases they are single family offices that “entrust the general management of their global wealth to a company that has its own resources and outsources part of its operations, as well as the reporting and consolidation of all its assets, and with the capacity to access good investment opportunities globally.” This, says Ulloa, together with its global presence, means that WE Family Offices have a unique UHNW heritage management model.
 

HSBC Completes the Restructuring of its Global Private Banking Division

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HSBC da por zanjada la reestructuración de su negocio de banca privada global
Photo: Amitauti. HSBC Completes the Restructuring of its Global Private Banking Division

When Stuart Gulliver took over the reins of HSBC back in 2011, the private banking business of the London-based Asian bank had presence in roughly 150 countries. Nowadays HSBC has private banking presence in around 50 countries, but the bulk of the restructuring is over.

After the bank was involved in a tax evasion scandal in 2015, with the so-called Panama Papers, Gulliver hired specialists from Rothschild and KPMG to lead the restructuring. They focused their efforts on eliminating or reducing private banks from, mainly Europe, but including countries such as Japan, Panama, Israel, Bermuda, Brazil and even Mexico.

In its most recent earnings release, which saw a 62% fall in earnings-affected by a lower income after the closure of several units-Gulliver wrote that “The restructuring of Global Private Banking is now largely complete, and although Global Private Banking is now much smaller than it was three years ago, it is deliberately positioned for sustainable growth with a focus on serving the personal wealth management needs of the leadership and owners of the Group’s corporate clients.”

The manager also mentioned that “2016 was a good year in which we achieved a solid performance of all our global businesses,” despite the fact that it collected a provision of approximately 700 million dollars for legal expenses related to investigations related to money laundering and tax evasion in countries like the USA, Argentina, France, Belgium and India.

Jonathan Gibbs: “I Do Not See Any Irrational Behavior In The Fixed Income Market or a Bubble”

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Jonathan Gibbs: “No veo un comportamiento irracional en el mercado de renta fija y, por lo tanto, no veo una burbuja”
Pixabay CC0 Public DomainJonathan Gibbs, Fixed Income Macro Strategies Specialist at SLI / Courtesy Photo. Jonathan Gibbs: "I Do Not See Any Irrational Behavior In The Fixed Income Market or a Bubble"

As a specialist in SLI Fixed-Income Macro Strategies, Jonathan Gibbs rules out the existence of a bubble for this asset, and to make his case, he compares the situation with the dot-com bubble of the late 1990s. “A bubble is a very specific concept, and is usually recognized by the irrational behavior of investors. Towards the end of the 1990s everyone bought shares in technology companies without even knowing what the business behind them was… I do not see that now in the bond market at all, I do not see any irrational behavior and, therefore, I do not see a bubble,” says the expert during an interview with Funds Society.

Thus, Gibbs answers the big question: where is the value in fixed income now? In his opinion, this depends on our economic vision. “If we think that inflation will remain weak, then returns will remain low for a long time.” Gibbs explains, however, that “if interest rates confirm their upward trend, some investors may suffer negative returns, but on the other hand, probably those who have opted for risky assets have done well.” For the expert, “what we need to recover is the negative correlation between stocks and bonds.”

Nor does the expert believe that we are seeing the end of the credit cycle in fixed income, a cycle which he considers “nebulous” and the beginning and end of which “is difficult to determine.” In his opinion, although “we have been experiencing a long period of expansion in the credit market, it does not mean that it is expensive: the spreads remain low, but I see no great reason for the credit cycle to be over,” he says.

As an investment specialist for the Absolute Return Global Bond Strategies Fund, Gibbs must explore market inefficiencies through active allocation to a wide range of positions. He uses a combination of traditional assets (such as bonds, cash and market instruments, and investment strategies based on advanced derivative techniques) embodied in a highly diversified portfolio. The fund can take long and short positions in markets, issues and groups of these through derivatives.

Inflation is coming

“We are very vigilant about the duration of sovereign debt, especially in the last weeks since Donald Trump’s victory,” he informs. For Gibbs, governments and central banks are comfortable with what is happening because they are getting what they want: inflation, the key element for fixed income investors. However, “if we analyze the rise in prices and its second-round effects, we see that prices do indeed rise, but it is a movement of prices, whereas inflation is a process.”

On Donald Trump’s fiscal policy, Gibbs questions whether it is the right time to do so. “Fiscal policy is a traditional way of stimulating the economy, but, and this is important, it’s extremely unusual to implement fiscal stimulus eight years after the economic recovery begins. It’s a strange moment to do so,” he says. Of course, he admits that his influence (Trump’s) in monetary policy may be greater outside the US, and “the shift from monetary policy to fiscal is probably a good thing.”

Regarding emerging markets, he points out that despite their new-found appeal, “it is about selecting the winners and avoiding the losers. Sometimes the losers are obvious, but there are also less obvious losers,” he warns. With their SLI Emerging Market Debt Fund, they are committed to countries like Peru: “It is a market that we like very much, for its political stability and its control over public spending.” On the duration, Gibbs insists that “it depends on the country in question”.

Finally, in Europe, they’re underweight in Italy and France. “We believe that political risk is high in these countries for the coming year. I do not think Marie Le Pen will win the elections in France, but the possibility can frighten. I think the French will avoid a radical party because of their more centrist tradition,” he added.
 

Emerging Debt is One of the Last Fixed Income Categories that Provide a Compelling Upside

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"La deuda de empresas de mercados emergentes es una de las últimas categorías en renta fija que proporciona un gran potencial alcista"
CC-BY-SA-2.0, FlickrThomas Rutz, co-fund manager MainFirst Emerging Markets Corporate Bond Fund Balanced / Courtesy photo.. Emerging Debt is One of the Last Fixed Income Categories that Provide a Compelling Upside

Nowadays, in an environment of higher growth, inflation and growing prospects of rate hikes, getting returns on fixed income is not easy, but Thomas Rutz, co-manager of the MainFirst Emerging Markets Corporate Bond Fund Balanced, believes that emerging corporate debt could offer attractive returns this year. In this interview with Funds Society, the manager explains that he prefers to take long-term credit risk and reaffirms the attractiveness of companies in emerging countries, which have improved their fundamentals in recent years, adjusting to falling commodity prices  and their currencies, and gaining strength for upcoming episodes of volatility. According to the expert, Latin America, cyclical sectors and high yield are the segments to watch.

– Emerging debt is an asset that is increasingly driven by international managers. What are the main benefits of these types of assets right now?

The main benefits are that EM corporates, in particular the high yield segment, offer an excellent risk-adjusted return profile in an environment of slowly rising interest rates. They are one of the last fixed income categories that provide a compelling upside. In addition, an allocation to emerging markets corporate debt provides an attractive opportunity to add diversification, as they exhibit a different risk profile to developed markets and provide investors with the opportunity to capitalize upon the future growth of private sector companies.

We believe that emerging markets are in the process of a multi-year convergence towards the developed world and the credit spreads (risk-premium) will narrow driven by those dynamics. There are very good prospects for a solid performance in 2017 due to better fundamentals with overall growth increasing from 4% in 2016 to 4.5%.

– Are the valuations attractive? In which segment are they more attractive: public or corporate debt?

Overall, emerging markets economies have greatly benefited from macroeconomic stabilization, improved legal and regulatory framework and better corporate governance, and also continue to benefit from very attractive demographics, such as population growth and the emergence of a new middle class. This will continue to drive domestic demand and economic output.

Valuations are therefore highly attractive. We prefer EM corporates over EM sovereign investments, since corporate credit spreads offer a better risk-adjusted return profile. In addition, credit spreads are higher and their duration is on average lower than those of sovereign debt. They, thus, offer better protection in a rising interest rate environment.

– Will the commodity rebound last and drive emerging markets? Which commodities will profit and which will suffer?

The recovery of commodity prices provided a crucial fundamental support to many emerging market countries and corporates last year. At current price levels, many firms already profit from massively increased cash flows which are then used to further deleverage their balance sheets.

– Have emerging market companies improved their fundamentals in recent years? If so, in what sense and in which segments of the market?

Yes, they certainly have! Leverage levels in EM corporates have stabilized markedly. Most companies have adjusted to the higher dollar and the lower commodity prices. This provides the base for corporate balance sheets to be more resilient to further volatility in currencies and commodities and, therefore, default rates are likely to decline.

Especially in the energy and mining & metals sectors, the firms responded to the crisis with cost-cutting initiatives, severe capex cuts and asset sales.  The extent of these adjustments has differed by region and country. In Russia, the flexible FX regime has largely mitigated the effects of declining oil prices. In Latin America, we are also seeing good progress, with many corporates taking proactive steps to cut CAPEX and sell assets (e.g. Brazil’s Petrobras or Vale).

– Do you prefer interest rate risk or credit risk at present?  Do the Fed’s future policies play a role in this?

We prefer credit risk for the reason that through credit spread compression, a positive return can be achieved, even in an environment of rising interest rates. Therefore, we manage our funds with a focus on the credit spread performance. Their duration is either in line with or shorter than the benchmark.

– What potential influence may Fed policies have on emerging corporate debt? Will its impact be smaller or greater than that of public debt?

Since, due to such developments as stronger commodity prices and the corrected macroeconomic imbalances, the overall position of the emerging markets is much stronger than a few years ago, Fed policy is likely have a comparatively milder impact on emerging market debts.

Moreover, potential protectionist trade measures by Donald Trump should be manageable since they have mostly already been priced in. In other cases, many investors have used short-term kneejerk reactions and dislocations as excellent initial buying opportunities. The proposed infrastructure program is likely to have a positive effect on commodities and thereby provide further attractive investment opportunities.

In which markets do you currently see the highest number of opportunities and why? Can you give some examples of sectors and names?

We currently see a lot of potential in Latin America as it is still largely undervalued. We, therefore, maintain a 25% overweight in the Latin American region. and our portfolio is tilted to more cyclical sectors, such as industrials, infrastructure and commodities. We like names such as Brazil’s Petrobras (energy) and Gerdau (steel). The latter, for example generates 45% of its revenues in North America and 35% in Brazil and is therefore well positioned for Trump’s infrastructure push in the coming years.

– Is China still a major risk for the emerging markets, or less so than before?

We neither did nor do we see China as a major risk for the emerging markets. Still, as long as valuations remain very stretched we will continue to have a large China underweight vs. the benchmark (2% in our fund vs. 20% in the JP Morgan CEMBI).

– Active management is key to your investment style in the emerging markets. Why? Is it a market that requires active investment management?

Yes, emerging markets require active management. We actively search for relative value in undervalued companies in the whole fixed income universe by applying a bottom-up, 5-step decomposition of the credit spread approach. Fund managers have to face the fact that there will again be significant winners and losers. A very active and opportunistic investment style will therefore provide additional alpha for those who are willing to continuously search for new opportunities and are able to adjust their positions. Our active management allowed us to outperform the benchmark by 560 basis points in 2016. For 2017, we expect another good year for active managers.

– How is the structure of the portfolio of the MainFirst EM Corporate Bond Fund Balanced set up? Is it a concentrated or a broad portfolio? Why? How many positions does it hold?

The MainFirst Emerging Markets Corporate Bond Fund Balanced is a fairly balanced mix of investment grade and high yield corporate bonds. The approach is opportunistic and based on the convictions of our fund management team. In a way, we are “bond pickers” and the resulting portfolio is a collection of global “best of” titles. This is at all times accompanied by diversification across multiple axes (regions, countries, sectors, ratings, duration). Currently, the portfolio holds 107 positions in 37 countries.

– How are titles selected? What characteristics do the titles need to have to be included in your portfolio?

Every investment is subjected to a risk and opportunity analysis, assigned a credit spread target, and usually replaced with another security once the target is reached. This encourages an active, target-focused style of investing. Emerging markets are ideally suited to a relative investing style.

– What do you like most, IG or HY firms at the moment, and why?

We currently like HY firms most, as they provide a greater upside potential through credit spread compression. With real yields hovering at very low levels, credit spreads are one of the last remaining potential sources of performance gains. Instead of focusing on long duration, the emphasis in the current market environment is on a thorough analysis and a disciplined investment approach to deliver performance. In contrast to most developed market fixed income instruments, whose performance is generally highly correlated with underlying government bonds, in emerging market credit products positive returns can still be achieved in an environment of slowly rising interest rates.

– Can you say something about the expected returns for this asset in 2017?

It is always difficult to predict performance, as unforeseen developments may always affect markets. However, if the current market conditions hold and trends continue as expected, we assume that the portfolio should be able to deliver the average portfolio yield plus roughly 200 basis points, which should result in a high single digit or even double digit return for 2017. As of February 7, 2017, the year to date performance for the MainFirst Emerging Markets Corporate Bond Fund Balanced is already at 2.76%.

Vasiliki Pachatouridi: “ETFs Will Benefit From a More Diversified Client Base Thanks to the MiFID II Directive”

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Vasiliki Pachatouridi: “La dimensión futura de los ETFs se beneficiará de una base de clientes más diversificada gracias a la directiva MiFID II"
Vasiliki Pachatouridi, courtesy photo. Vasiliki Pachatouridi: “ETFs Will Benefit From a More Diversified Client Base Thanks to the MiFID II Directive”

According to a report by Greenwich Associates and commissioned by BlackRock under the heading “ETFs in the European Institutional Channel”, the volume of assets in exchange-traded fixed income funds worldwide could exceed $2 trillion in 2025. There are those who draw attention to the high volumes of investment that this vehicle is attracting, but for Vasiliki Pachatouridi, iShares Fixed Income Product Strategist at BlackRock, the growth of debt ETFs should be taken into account in relation to the size of the underlying fixed income market and the investment fund sector as a whole.

In an exclusive interview with Funds Society, Pachatouridi states that, in November 2016, fixed-income ETFs reached almost US $600 billion in managed assets worldwide, with US-based fixed-income listed funds leading the way with US $421 billion in assets under management, followed by those domiciled in Europe with US $139 billion. “While assets managed by fixed-income ETFs have more than tripled since 2009, they still make up a small part of the underlying bond market: in fact, it accounts for less than 1%,” she explains. In fact, Pachatouridi points out that, if broken down by segment, high-yield fixed income ETFs currently have the largest share of the underlying market for this type of bond, at 2.4%, followed by listed fixed income funds with investment grade rating, representing only 1.8% of the underlying bond market with this rating.

As a reason for this growth, it should be noted that, during the past two years 25% of institutional investors have started using ETFs to access fixed income markets, and everything points to the fact that this interest is increasing. In  her opinion, the main catalysts for this trend are, “the purchase of bonds by central banks, which are shifting investors to US corporate debt; secondly, the consequences of regulations in trading models that, in particular, have reduced the ability of banks to maintain risky assets and act as liquidity providers within the framework of the main trading model and, finally, the pursuit of profitability.”

Over 55% of investors use ETFs to rebalance their portfolios. In the current market context we witnessed a strong upturn in risk inclination in all segments of corporate debt, which translates into inflows into exchange-traded fixed income funds. “November was a record month for TIPS ETFs (US bonds protected against inflation), which raised $ 2.4 billion, as inflation outlooks rose in the face of signs of upward pressure on prices, and the translation into practice of monetary policies at the budgetary level. At the same time, investment in conventional US Treasury bond ETFs fell ($ 2 billion), on fears of the Fed’s rate hike in December, which finally came.

The end of fixed income investment?

On the Fed’s monetary policy, Pachatouridi comments that, “now that rates are rising, some investors talk about the end of investment in fixed income. This position assumes that investors are always looking for profitability. The reality is that investors have balanced their portfolios, therefore, the debate no longer focuses on the interest of incorporating fixed-income securities into the portfolios but, instead, on how they should be maintained. Within a context of rising interest rates, we could witness a new rotation towards safer assets and bonds,” she explains.

In her opinion, the rise in rates does not necessarily lead to the widening of corporate debt spreads. “For example, if rates rise because growth is really improving, corporate debt spreads could also be reduced as benefits outlook improves and the risk of default decreases. However, if rates rise because markets are concerned about rising inflation (in the absence of growth) or, worse, due to the persistently high level of sovereign risk, spreads are likely to widen as long as the rest of the variables remain intact.”

More Investors

One of the challenges facing the future is the expansion of the ETFs’ investor base, which is currently very small. In this regard, for Pachatouridi, the future dimension of these products will benefit from a more diversified client base thanks to the MiFID II directive. “Reporting requirements on trading and on post-trading transparency represent clear progress that will improve the perception of the liquidity of European-domiciled ETFs, as they will provide more visibility to transactions in non-organized (OTC) markets.” In her opinion, other key catalysts for the growth of this market could be the standardized calculation of risk and trading, the increase in the supply of securities in ETFs for loans, the development of ETF derivative instruments, as well as greater acceptance of these products as collateral in over-the-counter transactions.

Pachatouridi states that one of the main differences between Europe and the US in terms of trading in fixed income assets, is the lack of consistent and reliable data on that activity in the Old Continent, which is something that MiFID II also seeks to solve. “Since trading is not required to be reported, there is a tendency to underestimate trading volumes in the secondary market for exchange-traded fixed income funds. MiFID II will improve the perception of the liquidity of the ETFs domiciled in Europe, since they will provide visibility to operations in unorganized markets (OTC).”

The ECB will have 10% of corporate debt

As regards the ECB’s corporate debt buy-back program and its impact on the market, the expert points out that, assuming the program runs until March 2017 and that the ECB continues to acquire debt at a rate of approximately 250/280 million Euros per day, bonds in the hands of the institution will add up to between 70 and 78 billion Euros. The market volume of corporate debt (non-financial) in Euros in the Euro zone amounts to approximately 950 billion Euros, so the ECB would hold less than 10% of this figure. “Incidentally, the ECB’s activity has had a considerable impact on the current price fluctuations and liquidity of eligible bonds for the program. The willingness of intermediaries and their ability to generate two-way markets and, especially, to offer securities to clients to start short positions have been hampered,” she says.

In her opinion, ETFs also play a role in the fragmentation of the fixed income market: “Corporate debt takes the form of a multitude of different securities and only a small part of them are suitable for inclusion in the general indices” In this regard, Pachatouridi adds, “ETF trading provides insight into the future state of the bond market: it’s electronic, transparent, and low-cost in a standardized and diversified product.”

Pioneer Investments: “In 2017, Europe will Experience the Highest Profit Growth that it has Seen in Recent Years”

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Pioneer Investments: “Europa registrará en 2017 un crecimiento de beneficios superior al que se ha visto durante los últimos años”
Photo: Fiona English, Client Portfolio Manager at Pioneer Investments. Pioneer Investments: “In 2017, Europe will Experience the Highest Profit Growth that it has Seen in Recent Years”

Clearly, 2016 has been a transition year for European equities. A true roller-coaster with dizzying news and an unexpected end to market rebounds due to President Trump’s arrival to the White House as US President. The recovery of investor confidence with which we have started the year will give way to multiple uncertainties and geopolitical risks.

According to Fiona English, Client Portfolio Manager of Pioneer Investments with responsibility for European Equity, markets have long been waiting for a tipping point in Europe’s growth and profits. During the last 3 to 4 years, however, we have been disappointed again and again. This year will be different.

“Although political risk has increased, it is likely that growth will finally pick up in 2017, and I believe we will also see an increase in corporate profits for European companies. In addition, consumption is accelerating and figures in many other areas of the economy have proven to be resilient. Even “after the referendum in Italy the European market rebounded 5% with some indices returning close to 10%”, explains the fund manager.

Another argument in favor of European equities for 2017 is that, as a result of the political risks facing Europe, the authorities of the Old Continent have changed their position and are starting to now be more in favor of measures that stimulate growth as opposed to the prevailing austerity of recent years. And this, as has happened in the United States, is good for the stock markets, explains Fiona English.

Positive returns

In addition, European companies have a large global exposure. At least 50% of revenue comes from outside Europe and for Pioneer this means that once global growth improves, European companies should improve their results as well. It is a positive scenario that makes us modestly optimistic about what European equities can do this year. Looking ahead, I think this year the European stock markets are going to experience improvement in their dynamics and will generate positive returns,” says English.

For Pioneer Investments’ Client Portfolio Manager, that conviction does not mean that everything is going to be a bed of roses. The political risks facing Europe are many and are not about to disappear, which will mean that “the stock markets will experience periods of volatility and sales waves at certain times.” For example, after the rebound of the last quarter, as a result of the Trump effect, it is likely that “the stock markets will go through a period of consolidation during the next 3 or 4 weeks. Investors will want to reap profits in the short term.”

Correction could occur due to some of the geopolitical events that we have in sight for the next few months, or perhaps to some other event overlooked by the market (for example, China hasn’t caused any turmoil for a while now). These declines may be definitely good entry points into the market. The Pioneer fund manager also mentioned the generalized outflow of bond market investors, which will basically could result in an inflow into equities – providing support to the asset class

Growth or Value, what will win this year?

“We’ve had 6 or 7 years in which growth strategies have done better than the market in general, especially since GDP growth in Europe was so weak that for a portfolio to do well, it had to be in areas of the market where there was profit visibility. Emerging markets was one of those areas, and the United States was another,” said English.

What we have begun to see over the past 6 months, however, is a rotation as valuations in those markets have fallen, and secondly, inflation expectations have rebounded. In this respect, the Pioneer fund manager believes that, indeed, the value segments of the market are starting to look more attractive.

“What we, at Pioneer, don’t believe is that this should be an exclusion scenario of the type ‘either growth or value’. No, we believe that we must opt for both, quality securities within the market, and for stocks with good fundamentals. The best example of this is the financial sector. It should do well this year, but that does not mean we’re going to opt for any security within this sector. We have to include in the portfolio those entities that are going to endure the political and regulatory challenges looming on the horizon,” she concluded.

In short, a balanced portfolio with both management styles is what will help investors to sail through the numerous rough patches that are anticipated along the way.